Regulation and Security Design in Concentrated Markets
Ana Babus, Kinda Cheryl Hachem · National Bureau of Economic Research · 2021
Regulatory debates about centralized trading assume security design is immune to market structure.We consider a regulator who introduces an exchange to increase liquidity, understanding that security design is endogenous.For a given security, investors would like to trade in a larger market and, for a given market structure, they would like to trade a safer security.We show that financial intermediaries design riskier securities after the exchange is introduced, even when the exchange leads to the origination of safer underlying assets.The results reflect a relative dilution of investor market power and motivate coordinated policies to improve investor welfare.